UPDATE 1-China plans to cut iron ore port stocks

(Recast with comments, background)

By Alfred Cang and Nao Nakanishi

SHANGHAI/HONG KONG May 20 (Reuters) - China's government plans to cut record iron ore stocks at Chinese ports, industry sources said on Tuesday, which may help lower domestic prices and strengthen the country's bargaining position with Australian miners.

Industry officials said iron ore stocks at Chinese ports had climbed to about 62 million tonnes as of end-April, with April imports reaching 42.85 million tonnes, their highest monthly level ever.

"Port congestion is severe. There's no space for iron ore at the ports," said a senior iron ore trader in Beijing. "The port stocks are the highest in history."

Beijing is considering raising warehouse fees, introducing a time limit for keeping iron ore at ports and urging steel mills to delay ore shipments from June in order to reduce port stocks, industry sources said.

"For those iron ore cargo ships that are still queuing to unload at port, the government will ask them to stock the iron ore in the warehouses outside of the ports, and clear customs later," a senior manager at a state-owned trading house said.

Government officials weren't immediately available to comment.

A flood of material from ports onto the domestic market would likely lead to lower spot prices at a time when Chinese steel mills and Australian miners BHP Billiton Ltd/Plc (BHP.AX) (BLT.L) and Rio Tinto (RIO.L)(RIO.AX) are in talks on 2008 contract iron ore prices.

"This isn't about freight rates. This is about whether China will buy iron ore on a spot basis or a contract basis," a source at an international trading company said on condition of anonymity.

"Certainly Beijing would like to see this material released to the open market but the thinking is longer term. The government is getting frustrated that independent merchants are bidding on spot material, driving prices higher and giving Australian miners greater justification for higher term contracts."

The benchmark spot Indian iron ore was quoted at around $192-$195 a tonne, including cost and freight, nearly double from about $100 a year ago, in part due to higher freight costs.

A shortening of vessels queueing to unload could also help bring down record-high freight rates for bulk carriers, one of the main arguments the Australian miners are using to demand a premium over supplies from Brazil.

Brazilian miner Vale (VALE5.SA)(RIO.N), the world's top iron ore producer, has already agreed on a 2008 price hike of 65-72 percent.

The benchmark Baltic Dry Index .BADI hit a record of 11,709 overnight, and is up nearly 30 percent this year, partly driven by soaring demand to ship all types of commodities to China.

This has pushed up costs for bringing a tonne of iron ore to China from Brazil to about $108 a tonne and from Australia to $44 in cape-sized ships.

"I think China has to agree to a freight premium because they need the iron ore from Australia. Nobody else can supply so much," said an executive at one of China's top shipping companies. (Additional reporting by Nick Trevethan; Editing by Michael Urquhart)